The terms current account deficit and trade deficit are often used interchangeably, but they have substantially different meanings. A current account deficit occurs when a country spends more on imports than it receives on exports. A trade deficit happens when a country's imports exceed its exports.
The current account deficit is a broader trade measure that encompasses the trade deficit along with other components.
Current Account Deficit
A current account deficit happens when a country spends more money on what it imports compared to the money it receives for what it exports. That means there is more money leaving the country than there is coming in. The current account of a country is the money it receives and pays for goods and services, investments, and other things such as any money sent abroad, salaries, and pensions.
Current account deficits mainly occur in developed or underdeveloped countries. The current accounts of emerging markets typically operate in a surplus.
A deficit isn't necessarily a bad thing. A country may have a deficit because it is importing the inputs it needs to produce goods and services it will export in the future. In that case, it may plan to create a current account surplus, which ultimately makes it an attractive investment opportunity for foreigners. The deficit may be problematic, though, if a country decides to overspend on its exports when it could be spending money on domestic production.
The longer a deficit remains on a country's books, the worse off it will be for its future generations. That means they will be saddled with excessive levels of debt and heavy interest payments to make to its creditors.
When a country has a deficit, it must find a way to make up for the shortfall. Deficits are reduced through the capital account, which records transactions between entities in one country and those in the rest of the world. That means the deficit can be reduced through the sale of assets, foreign currency, and through foreign direct investment.
Another way to reduce the deficit is to increase the value of its exports compared to its imports. But this can put economic or political pressure from international trade partners in the form of tariffs.
According to the U.S. Bureau of Economic Analysis, the United States' current account deficit totaled $124.8 billion in the third quarter of 2018, an increase from the second quarter of the same year. This means the U.S. continues to spend more on its imports than it is on its exports. The increase of the deficit as a percentage of U.S. gross domestic product (GDP) was 2.4 percent.
Trade Deficit
The trade deficit is the largest component of the current account deficit. It refers to a nation's balance of trade or the relationship between the goods and services it imports and exports. With a trade deficit, there is more being bought by the country than there is being sold. That means there are more imports than there are exports, so the country owes more to others than they owe to them. By contrast, though, if the total value of a nation's exports exceeds the total value of imports, the nation has a trade surplus.
The only way for a country to manage a deficit is for others to allow the country to borrow whatever it needs to make up for its shortfall.
Trade deficits aren't always a bad thing. A trade deficit means a country is able to keep industry for its exports going, and that it can continue to employ people. They may also encourage a country's leadership to invest in innovation and research and development (R&D).
The United States has been running the world's largest trade deficit. As of December 2018, the country's deficit totaled $79.5 billion, according to the U.S. Census Bureau. The country's deficit has been climbing mainly because of the increase in import and consumption of materials such as crude oil and electronics.
The United States has only run a trade surplus for five years since 1968.
KEY TAKEAWAYS
- A current account deficit occurs when a country spends more on its imports than what it receives for its exports.
- A trade deficit means there is more being bought than there is being sold by a country.
- If a current account deficit remains on the books for a long time, it can mean future generations will be burdened with high debt levels and large interest payments.
- Deficits aren't necessarily a bad thing. Current account deficits may signal an increase in future production of exports, while trade deficits may signal investment in innovation and/or R&D.
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